Enron may pinch economy
Fallout from scandals could drag on corporate credit, consumer confidence.
NEW YORK (CNN/Money) - The uncertainty raised by accounting irregularities at Enron Corp. and other U.S. companies probably won't derail the U.S. economy's recovery in 2002, many economists agree, but it could make the recovery slower.|
Since Enron's Dec. 2 bankruptcy filing - the largest in U.S. history - investors have been learning how much debt Enron's accounting practices hid from them, and the list of companies with egg on their face has grown longer every day. Meanwhile, long-term bond yields have risen, making the cost of borrowing higher for many companies.
"The loss of confidence in the financial reporting of Corporate America could hurt both consumer and business spending," said Sung Won Sohn, chief economist at Wells Fargo & Co. "The reduced availability and higher cost of credit, as well as the desire to strengthen the balance sheet, could cause firms to postpone capital spending plans and accelerate layoffs."
Meanwhile, a stock-market rebound, fueled by optimism about the economy's prospects for 2002, has been stunted, hurting consumers' balance sheets and confidence.
"It is ... clear that corporate profit data will be viewed with increasing skepticism," Boston Federal Reserve President Cathy Minehan said in a speech Monday at the Rhode Island Economic Summit. "Right now, anyway, equity markets may not be feeding into consumer confidence and demand in the way they seemed to be even two or three weeks ago."
'The mother of all credit expansions'
The latest U.S. recession - which many economists think began in March 2001 - was sparked when a bubble in corporate spending burst, leading to a drop in profits and stock prices, a halt in production and more than a million job cuts in a year.
Though most U.S. economists think the economy will recover in 2002, some have warned for several months that an excess of corporate and consumer debt would put a damper on spending, profits and stock prices throughout the year, making the recovery anemic at best.
"Private sector credit from 1999 through the first half of 2001 was adding $1.2 trillion per year. It was the mother of all credit expansions," said Maureen Allyn, chief economist at Zurich Scudder Investments.
Though most companies were probably not hiding their debt as aggressively as Enron, many were buying assets - especially new technology - and building up their production capacity, while their profits were growing very little or not at all. As a result, many ended up with excess capacity, excess goods and a ton of debt.
"That's all got to be cleaned up," Allyn said. "The stock market's going to struggle until that happens, and the economy at large will feel like it's moving through molasses, even though it will be moving forward."
Still, few U.S. economists are willing to declare the recovery dead yet, saying the productivity gains companies have made by cutting labor and other costs during the recession will be enough to fuel a recovery in both profits and the economy.
'No evidence of panic'
"While financial markets are focused on all the gloom ... they risk missing the incipient turnaround in corporate profits," said Robert DiClemente, chief U.S. economist at Salomon Smith Barney. "Based on the latest GDP figures, corporate earnings probably bottomed in the third quarter. Firms are making the necessary adjustments to restore profitability by reining in their costs, especially labor compensation."
Click here for CNN/Money's economic calendar
But those job cuts could weigh on consumer confidence, especially since many consumers already have high levels of debt - consumer credit has expanded every year since 1991, according to Federal Reserve data. Consumer debt's growth rate cooled off in 2001, but it did not shrink as it did during the 1990-91 recession, meaning consumers may still have to clean up their books, just like corporations.
And concerns about the accuracy of corporate accounting could continue to weigh on stock prices, removing a source of balance-sheet strength many consumers enjoyed in the 1990s. As a result, some consumers may choose to save cash rather than put it into stocks.
"It's not a dramatic fallout, and I don't see any evidence of panic," Zurich Kemper's Allyn said. "It's much more of a gradual adjustment; people have to diversify a little more. It just slows things down a little bit."
This period of adjustment could also cause the Fed - which cut interest rates 11 times in 2001 to boost spending and set the stage for a recovery - to leave rates alone for longer than they ordinarily do in economic rebounds. Inflation has not been a problem for some time, and keeping rates low will help ease the way for consumers trying to get their houses in order.
"That's why [Fed Chairman] Alan Greenspan was so desperate to get rates down - he wanted to make it easier to get through this," Allyn said. "The Fed won't be raising rates any time this year; I don't care what the economy does."
On the brighter side, most economists still think the damage done so far by Enron and other accounting embarrassments will likely not be strong enough to derail a recovery - as long as there aren't too many more unpleasant surprises waiting.
And history offers the reassuring lesson that scandals such as Enron's often accompany the end of booms in the stock market and the economy. While they're traumatic, they have not yet been catastrophic, and they often lead to necessary reform. In this case, for example, corporate transparency is almost certain to improve.
"During boom times, businesses have over-built, over-leveraged and misused accounting conventions. For example, in 1987, we had [Michael Milken's junk bond operations at] Drexel Burnham Lambert," Wells Fargo's Sohn said. "It was a huge crisis at the time, and we managed through it."